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The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or simply, “Dodd-Frank”) was enacted in July 2010 in response to the 2008 financial crisis. The Dodd-Frank Act created the Consumer Financial Protection Board (“CFPB”) as the primary regulatory body empowered to enforce new and existing lending regulations. In addition to enforcing new and existing lending regulations, the CFPB was designed to educate consumers and study the financial services and markets.

One of the CFPB’s first endeavors was to enact the Loan Originator Compensation Rule (the “Rule”), which implements Dodd-Frank’s requirements, as set by Congress. The Rule functions as a series of amendments to Regulation Z.1 On January 10, 2014, the CFPB enacted the Rule, which brought small mortgage lenders and seller or private financers under a previously unknown level of federal regulation. The new regulation has changed private lending, leading some lenders to consider whether the level of risk is untenable. The Rule imposes hefty penalties for violations, with fines from $5,000 per violation per day to $25,000 per violation per day for a “reckless” violation and up to $1,000,000 per violation per day for a “knowing” violation.

Before the CFPB enacted the Rule, small mortgage lenders engaging in no more than five mortgages per year were often exempt from the definition of a “creditor” under Regulation Z. Therefore, private lenders looking to finance property between family members and some seller financers are now loan originators who must comply with the Rule, or work directly with a licensed mortgage broker.

The Rule contains some exemptions. For example, it only applies to consumer loans secured by a one to four unit dwelling or a property including such a dwelling. It does not apply to reverse mortgages, home equity lines of credit, or loans made for business, commercial, or agricultural purposes. Further, two exemptions exist for seller financers:

One-property exclusion under 12 C.F.R. § 1026.36(a)(5):

– The lender is a natural person, estate, or trust and provides seller financing for only one property in any 12 month period;
– The lender owned the property securing the financing;
– The lender did not construct, or act as a contractor for the construction of, a residence on the property in the ordinary course of business; and
– The financing must: (1) Have a repayment schedule that does not result in negative amortization; and (2) have a fixed interest rate or an adjustable interest rate that resets after five or more years, subject to reasonable annual and lifetime limits.

Three-property exclusion under 12 C.F.R. § 1026.36(a)(4):

– The lender is any entity that provides seller financing for three or fewer properties in any 12 month period;
– The lender owned the property securing the financing;
– The lender did not construct, or act as a contractor for the construction of, a residence on the property in the ordinary course of business; and
– The financing must: (1) Be fully amortizing; (2) be financing the lender has determined in good faith the consumer has a reasonable ability to repay; and (3) have a fixed interest rate or an adjustable interest rate that resets after five or more years, subject to reasonable annual and lifetime limits.

Private lenders and seller financers that do not fall under the exclusions and do not wish to follow the complex regulations for loan originators under the Rule still have a few options. These options include (1) making loans not secured by a dwelling or property that includes a dwelling; (2) making open end home equity lines of credit or time share transactions; (3) making loans for business, commercial or agricultural purposes; (4) extending credit to entities that are not natural persons, including government agencies or instrumentalities; and (5) working with a licensed, Regulation Z compliant loan originator. However, pending any new exceptions for “family loans” or other types of private mortgage lending, these practices may now be too daunting to contemplate.

Nicole Villaroel is a real estate attorney at Hackleman, Olive & Judd. She focuses her practice on commercial and residential real estate transactions.

[1]See 12 C.F.R. § 1026. Regulation Z is a Federal Reserve Board regulation that increases disclosure requirements for lenders. It is the implementing regulation of the Truth in Lending Act.